Business Statistics: A First Course 3/3 2003 Prentice-Hall, Inc.

Chapter 10 10 -1
Business Forecasting
Chapter 6
Adaptive Filtering as a
Forecasting Technique
Chapter Topics
Introduction
How the Model is Used in Forecasting
Chapter Summary
Introduction
The adaptive filtering approach also depends
heavily on historical observations.
More complicated data patterns such as those
with cycles are easily accommodated.
The model makes it possible to learn from
past errors and correct for it before making a
final forecast.

Introduction
In both the moving average and the
exponential smoothing models, the forecaster
depended on selecting the right value for the
smoothing constant or the weight.
In the adaptive filtering technique, the model
seeks to determine the best set of weights
that needs to be used in making a forecast.

Introduction
The model is capable of generating
information about past inaccuracy and
corrects itself.

Basic Elements of the Technique
The technique has two distinct phases:
The first phase is the adapting or training of a set
of weights with historical data.
The second phase uses these weights to make a
forecast.
As in the previous methods, we compute the
error for the forecast.
The weights are adjusted based on the
errors, and a new forecast is made.
Business Statistics: A First Course 3/3 2003 Prentice-Hall, Inc.
Chapter 10 10 -2
Basic Elements of the Technique
Note how we forecast for period 5, for
example, using the weights:


The error will be computed as:


1 4 2 3 3 2 4 1 5

Y w Y w Y w Y w Y + + + =
5 5 5

Y Y e =
Adapting and Training Process
Hypothetical Data Used in Adjusting the Weights by Adaptive Filtering


Time Observed Data Weights Forecast


1
2
3
4
5
6
7
8
9
10
11
12
13
1 Y
2 Y
3 Y
4 Y
5 Y
6 Y
7 Y
8 Y
9 Y
10 Y
11 Y
12 Y

1
2
3
4
w
w
w
w

1
2
3
4
w
w
w
w








5
Y













13
Y

Training Phase
In the training phase we use the following equation
to adjust or revise the weights:




| |
1
2 '
/ 2
+
+ =
i t t i i
Y y e k w w
th weight revised The
: where
'
i w
i
=
Training Phase
= the old i th weight i
w
k = a constant term referred to as the learning constant

2
/ y e
t = the standardized error of forecast in the period

1 + i t
Y
= the observed value at period t i +1
i = 1, 2, , p (p = number of weights)

t = p +1, p +2, , N (N = number of observations)

y = the largest of the most recent N values of Y.
Training Phase
As you can see, the revised set of weights is
equal to the old set of weights plus some
adjustments made for the error.
The adjustment for each weight is based on:
The observed value
The value of the learning constant k
The error for that forecast.
Training Phase
The learning constant allows the weights to
be changed automatically as the time series
changes its patterns.
The steps for this adjustment process
involves:
Specifying the number of weights
Specifying the learning constant (k).
Business Statistics: A First Course 3/3 2003 Prentice-Hall, Inc.
Chapter 10 10 -3
Training Phase
There are at least two ways of assigning the
initial weights:
Forecaster uses his/her judgment to assign the
weight.
A statistical approach is used to determine the
weight as shown below:

where
N w
i
/ 1 =
N = the number of observations in the data series.
Training Phase
For quarterly data, N would equal 4 and for
monthly data, N would equal 12
The minimum number of weights that can
be used in adaptive filtering is two.

The learning constant (k) has a value
between 0 and 1.
Training Phase
If we choose a higher value for k, then we
can expect rapid adjustment to changes in
patterns, making it difficult to find the
optimal weight.
If we select a small value for k, the number
of iterations needed to reach optimal
weights may increase significantly.
Training Phase
As a rule, k can be set to equal to 1/p where
p is the number of weights.
Alternative values of k are used, and the one
that has the smallest standard error is
selected.
When data have a great deal of variation, a
smaller k is recommended.
Example
Table6.3 Quarterly Production Output
Period Year Quarter Output
1 2005 I 100
2 II 93
3 III 113
4 IV 125
5 2006 I 110
6 II 95
7 III 124
8 IV 136
9 2007 I 125
10 II 98
11 III 129
12 IV 142
Example
Step 1:
Graph the data to see what observations can
be made from the scatter plot.

Business Statistics: A First Course 3/3 2003 Prentice-Hall, Inc.
Chapter 10 10 -4
Example
60
80
100
120
140
160
I
2005
II III IV I
2006
II III IV I
2007
II III IV
Time
P
r
o
d
u
c
t
i
o
n
Example
Step 2:
Select the weight. Given that we have
quarterly data, the weight will be:
1/n =0.25 for each quarter.
Step 3:
Since there is seasonality in the data, we
may want to give more weight to the quarter
prior to the one for which the forecast is
being made.
Example
Suppose we arbitrarily give the following
weights for each quarter:
Q1 = 0.2
Q2 = 0.2
Q3 = 0.2
Q4 = 0.4

Example
Step 4:
The forecast for the first quarter of 2006 will
be:

107 ) 102 )( 4 . 0 ( ) 93 )( 2 . 0 ( ) 113 )( 2 . 0 ( ) 125 )( 2 . 0 (

5
= + + + = Y
Step 5:
The error associated with this forecast will be:

Error = Observed value in period 5 Forecast in period 5

= 110107= 3.0
Example
Step 6:
Compute a new adjusted (or optimized) set of
weights.
To do this, we have to know the learning
constant (k).
We can set k to equal 1/p, which in this case
would be 0.25, since we have used four
weights.
Example
Step 7:
Compute a new adjusted set of weights:

( ) | | 2120 . 0 125 125 / 107 110 ) 25 . 0 ( 2 2 . 0
2 '
1
= + = w
( ) | | 2108 . 0 113 125 / 107 110 ) 25 . 0 ( 2 2 . 0
2 '
2
= + = w
( ) | | 1999 . 0 93 125 / 107 110 ) 25 . 0 ( 2 2 . 0
2 '
3
= + = w
( ) | | 4098 . 0 102 125 / 107 110 ) 25 . 0 ( 2 4 . 0
2 '
4
= + = w


Business Statistics: A First Course 3/3 2003 Prentice-Hall, Inc.
Chapter 10 10 -5
Example
Step 8:
The forecast for period 6, the second quarter
of 2006, is now based on the new weights
that we have just computed.

110 ) 93 )( 4098 . 0 ( ) 113 )( 1999 . 0 ( ) 125 )( 2108 . 0 ( ) 110 )( 2120 . 0 (
6

= + + + = Y
Example
Step 9:
This process of using the newly adjusted
weights is used to compute the forecasts for
the subsequent quarters (Table 6.4).

Example
Table 6.4 Forecast of Quarterly Production and Adjusted Weights for the 12
Periods


Period Year/Quarter Output Forecast
t
t
Y
t
F
1
W
2
W
3
W
4
W

1 2005: I 102
2 II 93
3 III 113
4 IV 125 0.2 0.2 0.2 0.4
5 2006: I 110 107 0.2120 0.2108 0.1999 0.4098
6 II 95 110 0.1579 0.1493 0.1443 0.3641
7 III 124 91 0.2594 0.2669 0.2779 0.4849
8 IV 136 149 0.2090 0.2283 0.2332 0.4341
9 2007 I 125 127 0.2030 0.2228 0.2327 0.4336
10 II 98 126 0.1093 0.1209 0.1398 0.3624
11 III 129 90 0.2132 0.2534 0.2840 0.4939
12 IV 142 155 0.1678 0.2189 0.2400 0.4461

Example
Step 10:
Refine the weights by substituting those
weights that are generated at the end of the
training period:





1678 . 0
'
1
= w
2189 . 0
'
2
= w
2400 . 0
'
3
= w
4461 . 0
'
4
= w
Example
Step 11:
Using the computer program provided with
this book, this process is continued until we
have minimized the standard error and no
more reduction is noted with repeated
iterations.



Example
AdjustedWeightsandtheStandardError after 200I terations


I teration Standard
Number Error
1
W
2
W
3
W
4
W

1 22.4013 0.1682 0.2188 0.2454 0.4419
2 20.8818 0.1213 0.2179 0.2771 0.4712
3 20.2727 0.0766 0.2121 0.3063 0.5023
4 19.7485 0.0344 0.2021 0.3331 0.5353
5 19.2626 -0.0051 0.1886 0.3572 0.5698
. . ..
120 4.6367 0.0990 0.1435 0.3307 1.3484
130 4.4662 0.1082 0.1694 0.3328 1.3451
140 4.4153 0.1227 0.1804 0.3274 1.3507
150 4.4179 0.1321 0.1785 0.3250 1.3613

Business Statistics: A First Course 3/3 2003 Prentice-Hall, Inc.
Chapter 10 10 -6
Example
Step 11:
The forecast for period 13 will be:





60 . 142 ) 125 )( 3507 . 1 ( ) 98 )( 3274 . 0 ( ) 129 )( 1804 . 0 ( ) 142 )( 1227 . 0 (

13
= + + + = Y
Chapter Summary
The adaptive filtering approach depends
heavily on historical observations.
But, in this technique more complicated
data patterns such as those with cycles are
easily accommodated.
Additionally, adaptive filtering makes it
possible to learn from past errors and
correct for it before making a final forecast.
Chapter Summary
In comparison with the moving average
and the exponential smoothing models,
the adaptive filtering model seeks to
determine the best set of weights that
needs to be used in making a forecast.
The model is capable of generating
information about past inaccuracy and
corrects itself.
Chapter Summary
The technique has two distinct phases.
The first phase is the adapting or training
of a set of weights with historical data, and
the second is to use these weights to
make a forecast.
We discussed how the weights are
selected at the beginning and how finally
the revised weights are used in making a
forecast.
Chapter Summary
Two important elements of the technique
are the selection of the weights and the
learning constant (k).
Use of the computer program specially
designed for this chapter makes the
process of forecasting very easy.